On August 16, 2017, trade representatives of the United States, Mexico and Canada will convene in Washington, DC for the first of seven scheduled rounds of negotiations in relation to the North American Free Trade Agreement (NAFTA). The negotiations have been covered extensively in national and international media and, given the scope of the interests at stake, we expect that coverage to only intensify.

To provide practical insights to stakeholders in key industries, we have focused this update on the context of the negotiations, the interests and objectives laid out by the states in advance of the talks, and our strategic view of what interested observers should watch for. We will periodically publish sector-focused insights as the negotiations develop.

Context

NAFTA came under sustained criticism during the 2016 US Presidential election campaign, including in particular US President Donald Trump’s linking of NAFTA with trade deficits between the US and Mexico. Mr. Trump has suggested that the bilateral trade deficit with Mexico reflects a fundamental unfairness in NAFTA vis a vis the interests of US workers and businesses, and reportedly came close to withdrawing the US from NAFTA in late April, 2017.[1]

On May 18, 2017, however, the US administration announced that it would initiate negotiations with the intent to “moderniz[e]” NAFTA, though it left the door open to a unilateral withdrawal if the parties are unable to reach a “fair deal” for the US.[2] As required under the Bipartisan Congressional Trade Priorities and Accountability Act of 2015, the Office of the US Trade Representative (USTR) released a summary of objectives for the upcoming negotiations.[3] While the document is clearly not irrelevant, much of its substance is too vague to predict with specificity the revisions or amendments that US negotiators will seek.

Negotiating against the clock

The parties are under time pressure from several sources to conclude the negotiations quickly, which may pose challenges given the often protracted nature of complex trade negotiations.

First, the US legislative grant of “fast-track” Presidential Trade Promotion Authority will lapse in July 2018, meaning that if negotiations drag on it may be necessary to seek renewed authorization from Congress, which has recently shown broad bipartisan scepticism of free trade agreements in general, and investor-state dispute resolution mechanism in particular.[4]

Second, Mexico will hold Presidential elections in July 2018, and President Enrique Peña-Nieto will be a lame-duck until his successor is inaugurated in January 2019. It may be difficult for the Mexican government to make credible commitments during such time, especially if an opposition party wins the election.

Third, the negotiations are likely to play a role in the 2018 mid-term US elections scheduled for November 2018, for which candidates’ campaigns are already gearing-up.

With these (and doubtless many other) pressure-points in mind, the parties are pushing to conclude the negotiations quickly, in order to avoid being overtaken by events. It may help that the parties are not likely to need to start from scratch, as the TPP is expected to provide a foundation for modernizing certain features of NAFTA – somewhat ironically, in light of the US administration’s decision to withdraw from that agreement.[5] While trade negotiations often take years, if the parties are able to reach agreement on changes to NAFTA quickly, the fallout may be felt much sooner than in the normal course.

Key issues on the table

Canada, Mexico and the United States have each offered public insights on their priorities in advance of the negotiations, including the United States Trade Representative’s release of negotiating objectives on July 17, 2017. All three states have cautiously indicated a desire to update and upgrade NAFTA, and in all events to do no harm. That sentiment appears to reflect widespread economic and political concerns about the impact of a US withdrawal from NAFTA, which could dramatically harm North American consumers, producers and retailers.[6]

Some of the anxiety around the negotiations stems from the US stance on revising NAFTA to address the current trade deficit with Mexico. Some commentators have suggested that trade policy is an ineffective tool for addressing bilateral deficits, and that focusing on eliminating bilateral trade deficits without considering the overall impacts of a trading relationship would be misguided.[7]

Putting aside concerns over the fallout of a US withdrawal or the wisdom of using NAFTA to reduce the trade deficit with Mexico, what are some of the critical parts of NAFTA that could, if revised in a renewed agreement, affect businesses operating in North America?

Labor Regulation – The US has proposed to incorporate a number of labor regulations into a revised NAFTA, including requiring the parties to “take initiatives to prohibit trade in goods produced by forced labor”, regardless of the country of origin. The inclusion of such obligations would build on the global trend toward the implementation of specific supply chain diligence and other requirements to hold businesses accountable for violations of human rights.

Rules of Origin – The US may seek to tighten Rule of Origin requirements for products to receive the benefit of NAFTA preferences, which could affect a range of industries, including in particular manufactured goods and petroleum products blended with diluents from non-NAFTA states. The objective appears to be to incentivise enterprises to invest in NAFTA-based manufacturing, and at the same time to discourage outsourcing, although it is not clear from a macroeconomic perspective that such measures would be effective.

Anti-dumping and Countervailing duties – The US has proposed eliminating the Chapter 19 dispute settlement mechanism, which provides for state-to-state resolution of challenges to domestic trade enforcement actions. It is unlikely that Mexico or Canada would be willing to weaken or eliminate Chapter 19, making this a potential point of contention in the negotiations.

Investor-State Dispute Settlement (ISDS) – The published US negotiating objectives tabled potential changes to NAFTA’s dispute settlement provisions. It is possible that the modernized approach taken in the TPP, or the recently concluded Canada-EU Trade Agreement (CETA), may form the basis for revising NAFTA’s investor-state dispute settlement procedures. Although vague, the US objectives suggested a liberalized procedure for third-party amicus submissions to dispute settlement panels by non-governmental entities, building on the trend toward greater transparency in investor-state dispute settlement. Despite widespread scepticism in government toward ISDS, business groups, including the National Association of Manufacturers, have lobbied US Trade Representative Richard Lighthizer to maintain NAFTA’s investor-state dispute resolution mechanisms.

What happens if the US withdraws from NAFTA?

President Trump has threatened that if the renegotiation fails to reach a “fair deal”, he will withdraw from NAFTA.[8] In practical terms, the withdrawal of the US from NAFTA would mean that Canada-US trade would be governed by their original bilateral FTA, which dates back to 1988. NAFTA itself would remain in effect between Canada and Mexico, meaning that the primary impact of US withdrawal would be the end of free trade with Mexico.

The fallout – which would likely lead to the imposition of tariffs on US exports to Mexico on numerous products – would very likely wreak havoc on the integrated supply chains that have become established in North America in the decades since NAFTA was implemented. Notwithstanding the Trump administration’s stated desire to reduce the trade deficit with Mexico, some analysts have suggested that withdrawal might only exacerbate the issue.[9]

Practical takeaways

While there are real risks associated with failure, the stakes for all of the parties are sufficiently high to remain optimistic that the parties will conclude a revised agreement. It is too soon to tell what that agreement might say, although stakeholders should stay abreast of developments given the time pressure facing all parties to the negotiation.

While the breadth of NAFTA touches innumerable sectors in complex ways, stakeholders in several key industries should watch closely, including manufacturers (especially those with cross-border supply chains), businesses in the energy sector, and producers and distributors of agricultural products. In addition to the potential fallout for businesses with integrated operations in North America, companies in non-NAFTA states should watch closely to identify potential opportunities to expand their trading relationships with the NAFTA states as the negotiations develop.

Herbert Smith Freehills LLP is authorised and regulated by the Solicitors Regulation Authority.

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